An Introduction to Self-Employment Tax
If you're thinking about changing from full time employment to freelance work then you will no doubt be excited at the prospect of striking out on your own, choosing your own jobs and being your own boss. But there are also a number of other issues, not quite so glamorous or exciting but important nevertheless, to consider when you are planning your career change. One such issue is Self Employment Tax, a tax that you will not have been paying before, but need to take account of as a freelancer.
Self Employment Tax is a tax that employees of companies do not have to pay, although it is the equivalent of the Federal Contributions Act (FICA) tax that is taken from employees to be used for paying Medicare and Social Security. Self Employment Tax is deducted from your net self-employment earnings. Most people are unaware that they are paying this tax whilst employees of companies because their employer automatically takes care of paying half of it, amounting to 7.65%. From the moment you are classed as self-employed however, whether as a sole proprietor or independent contractor, you are required by law to pay the total 15.3% charge yourself as a part of your tax return. The moment your earnings as a freelancer go over $433 (and if they don’t you might want to rethink the direction of your career) you are required to pay that 15.3% levy. In addition, should your earnings go over $106,800 you will then be required to pay 2.9% on every dollar you earn over that. Of the money you pay, social security take 12.4% and Medicare get 2.9%.
How can you be sure that you must pay it? In a nutshell if you are self-employed in any way at all, you’re going to have to pay the tax. The tax will be levied from your bet business earning and whether your return that you file is a Schedule E with income from a partnership, a Schedule F or a Schedule C (which covers profit and loss from business) you will be required to submit a Schedule SE as part of your return and to pay the Self Employment Tax. There are some exceptions - the tax applies to any income that results from your earnings and job, but not income from investments. Capital gains, interest, dividends, royalties and rents are not taxed.
Lastly, as a self employed worker or contractor you also need to remember that it is now your responsibility to handle all of your finances yourself. You no longer have the luxury of an employer to handle all the admin, take care of your pensions or insurance, advance you payday loans or ensure your taxes are all correct. You may have escaped the confines of the old office environment but you might well find a new level of paperwork waiting for you when it comes to self employed taxes. You need to work out your SE Tax using the Schedule SE and then submit this figure as part of the "other taxes" section on your 1040 form. You will also be required to make an estimate every quarter and to pay that estimate on time.
Alex Simmonds is a journalist and copywriter.
Suggested Reading
Working for Yourself: Law & Taxes for Independent Contractors, Freelancers & Consultants
